When Toys “R” Us filed for Chapter 11 in September, capping an unexpectedly sharp collapse for a company whose bonds mere months earlier were trading just shy of par, the prevailing consensus was that once the company's balance sheet is restructured, it would continue its existence without substantial operational changes and with largely the same number of stores and employees. However, in the first confirmation that the company's collapse was much more extensive than just the result of excess leverage, Bloomberg reports that Toys "R" Us is considering closing at least 100 U.S. stores - and as many as 200 - in the face of weak holiday sales. According to Bloomberg's sources, the store closures are coming after a sharp contraction in sales which declined 15% this Christmas-shopping season from a year earlier.
The Wayne, NJ-based company operated 879 U.S. stores as of the end of January, which means that between 11% and 22% of the company's store base is about to be shuttered, resulting in thousands of layoffs.
The announcement was a double whammy from the company which previously stunned bondholders when news leaked it was preparing for bankruptcy. While shutting stores is common practice for bankrupt retailers, Toys “R” Us had previously said that its Chapter 11 filing "wouldn’t herald a big retrenchment for the largest toy-store chain" according to Bloomberg. In fact, CEO Dave Brandon went so far as to say in September that the company was pushing ahead with plans to open more stores in some cities, and was contemplating extending the lease on its Times Square location, which opened in August as a temporary holiday shop.
Turns out it lied.
But it's not just Toys employees who are on the hook: the prospect of Toys “R” Us closing locations is another major blow to its biggest suppliers, Mattel and Hasbro, both of which were hammered after Toys' bankruptcy, and whose shares again fell to session lows on Monday after the news of the store closures. Mattel declined as much as 4.5% to $14.78, while Hasbro dropped 3.2% to $91.02.
As we reported previously, the toymakers have already blamed Toys “R” Us’ bankruptcy for their declining sales. Mattel, the world's biggest toymaker and maker of Barbie dolls and Fisher-Price, was hit particularly hard, with sales plunging in North America last quarter resulting in a suspension of the company's dividend.
Meanwhile, with Amazon stealing market share from every conventional retailer, and with sales continuing to tumble, Toys “R” Us may have to shut even more stores in the months ahead, which the recent Chapter 11 filing will make especially easy.
The bankruptcy process makes it easier to exit leases and shut down the company’s worst-performing locations. And the company has said that it would continue to evaluate its store fleet as part of the restructuring process.
Which means that in addition to Toys "R" Us and its suppliers, also on the hook are the numerous malls and retail outlet locations where the company's store are located, and which will soon stop paying their leases.
Ultimately, however, it is all about the toy store's turnaround, which appears to not be going as planned:
Weak holiday results threaten to complicate the retailer’s plans to get its finances in order and emerge from bankruptcy with an improved balance sheet. Before filing for bankruptcy, the company had been weighed down by roughly $5 billion in debt, stemming from a leveraged buyout last decade led by Bain Capital.
Separately, Bloomberg reported previously, Toys “R” Us has also announced plans to close at least 26 stores in the U.K., which is outside the purview of the bankruptcy. The idea there is to reduce its emphasis on warehouse-size stores, letting the company focus on better-performing small shops and online operations.

Reviewing first day motions from a company's chapter 11 docket, and more specifically the CEO's declaration, can be a great way to learn exactly what happened in the days/weeks leading up to a bankruptcy filing. The company spends millions of dollars every month on expensive lawyers (Kirkland & Ellis in the case of Toys "R" Us), investment bankers (Lazard), turnaround advisors (Alvarez & Marsal), claims administrators, etc., who all spend many sleepless nights in the days leading up to a filing trying to make sure the first day motions are as informative as possible.
With those high expectations, you can imagine our surprise when we opened the Toys "R" Us CEO's declaration to find this "preliminary statement":
Yes, Kirkland & Ellis was paid $800 an hour (ish) to type up the Toys "R" Us jingle in a court filing. Bravo!
In any event, once you get beyond the amateur-hour antics, CEO David Brandon explains why Toys "R" Us was forced to file for bankruptcy in such a hurry. While debt service on a excessively levered capital structure was a big part of it, Brandon explains that media speculation over a potential bankruptcy filing led to a rapid tightening of trade terms just as the company was trying to build inventory ahead of the holiday season. Here are the details:
1. Debt - Apparently spending the majority of your FCF on debt service while ignoring capital improvements and store remodels is a bad long-term business strategy for a bricks-and-mortar retailer.
Toys “R” Us, however, has been operating for more than a decade with significant leverage, necessitating the use of substantial amounts of cash each year (approximately $400 million) to service the more than $5.0 billion of funded indebtedness. But these substantial debt service obligations impair the Company’s ability to invest in its business and future. As a result, the Company has fallen behind some of its primary competitors on various fronts, including with regard to general upkeep and the condition of our stores, our inability to provide expedited shipping options, and our lack of a subscription-based delivery service.
2. Vendors - Media speculation of an imminent bankruptcy filing starting on September 6th caused 40% of vendors to restrict shipments and demand "cash on delivery" for new inventory purchases which would have required $1 billion incremental liquidity.
More recently, the Company’s need for a comprehensive solution to its capital structure issues caused widespread “bankruptcy” speculation in the media, leading to a severe constriction in the Company’s trade terms. More specifically, in late July the Company hired Kirkland & Ellis LLP and Alvarez & Marsal North America, LLC, complementing its retention of Lazard, to consider restructuring and capital structure solutions.
A news story published on September 6, 2017, reporting that the Debtors were considering a chapter 11 filing, started a dangerous game of dominos: within a week of its publication, nearly 40 percent of the Company’s domestic and international product vendors refused to ship product without cash on delivery, cash in advance, or, in some cases, payment of all outstanding obligations. Further, many of the credit insurers and factoring parties that support critical Toys “R” Us vendors withdrew support. Given the Company’s historic average of 60-day trade terms, payment of cash on delivery would require the Debtors to immediately obtain a significant amount—over $1.0 billion—of new liquidity.
3. Holiday Inventory Build - Finally, this all came at the exact moment that the company was trying to build inventory for the holiday selling season.
The timing of all of this could not have been worse, as the Company is in the process of building holiday inventory. While birthdays, new game releases, and other special events drive year-round sales, the holiday season is the most important for annual results. In the fourth quarter (the weeks prior to Christmas), the Company generates approximately 40% of its annual revenue.
To prepare for the holiday season, Toys “R” Us significantly increases inventory in September to fill store shelves with the selection and variety of products our customers expect. Accordingly, I believe it is critical that the Company reopen its supply chain immediately to ensure a successful holiday season.
Given that, it's somewhat ironic that Bloomberg notes this morning how important Toys "R" Us is to vendors and how Mattel and Hasbro couldn't possibly allow the company to liquidate.
Rest easy, kids. Toys “R” Us Inc. isn’t going anywhere, at least not if the makers of Barbie and Transformers have their way.
Yet, the company, which operates about 1,600 stores globally, will likely survive because manufacturers such as Mattel Inc., Hasbro Inc. and closely held MGA Entertainment Inc. need the last remaining toy chain. These vendors are eager for whatever remaining leverage they have against the might of Amazon and Wal-Mart, the bane of all companies focused on a single category of shopping.
“Oh my God, they are very important, and people don’t understand,” Isaac Larian, founder and chief executive officer of MGA, said of the toy chain. “That’s the only place where kids can go and just buy toys. There is no toy business without Toys ‘R’ Us.”
In many respects, suppliers have been propping up Toys “R” Us for years, according to Moody’s Corp. analyst Charlie O’Shea; they give the chain exclusive products during the holidays and funds for promotions to help it compete with the general merchandisers. The manufacturers offer this support because they want a place to sell toys at full price, year round. Major brands have also been funding an overhaul of Toys “R” Us stores by adding more featured areas for top brands such as Mattel’s American Girl dolls.
In the toy business, the incentive is particularly powerful. Last year, Toys “R” Us accounted for 11 percent of sales at Mattel and 9 percent at Hasbro -- the second most at both companies after Wal-Mart.
Meanwhile, many have speculated this week over how/why TOY bonds traded off 75 points on the company's filing? How could they be so wrong? While the timing of the filing was probably somewhat of a surprise, we can't help but wonder whether this simplistic org structure might have contributed in some small way?

Toys “R” Us Inc., the largest US "brick and mortar" toys retailer, filed for bankruptcy late on Monday night, as a result of a crushing post-LBO debt load and relentless competition from warehouse and online retailers, the "latest blow to a retail industry reeling from store closures, sluggish mall traffic and the gravitational pull of Amazon.com" according to Bloomberg. The Chapter 11 filing is among the largest ever by a specialty retailer and casts doubt over the future of its about 1,600 stores and 64,000 employees. It comes just as Toys ‘R’ Us is gearing up for the holiday shopping season, which accounts for the bulk of its sales, and as vendors halt shipments to the now insolvent retailer.
With assets of $6.9 billion, it’s the second-largest retail bankruptcy, trailing the filing in 2002 by Kmart, which had $14.6 billion in assets.
The company was saddled with debt from a $6.6 billion buyout in 2005 led by KKR, Bain Capital and Vornado Realty Trust. Toys ‘R’ Us has bonds coming due over the next few years that lost most of their value this month.
“While today’s decision does not necessarily mean it is game over for Toys ‘R’ Us, it brings to a close a turbulent chapter in the iconic company’s history,” said Neil Saunders, managing director of GlobalData Retail.
“What they have going for them is they are the last major player in their market,” said David Berliner, a partner and restructuring specialist with BDO Consulting. “The vendors don’t want to see them fail, so I think they have a good opportunity to survive.”
The company listed debt and assets of more than $1 billion in its Chapter 11 filing submitted Monday at the U.S. Bankruptcy Court in Richmond, Virginia (an odd place for such a major bankruptcy filing). Prior to filing, the company said that it had secured more than $3 billion in financing from lenders including a JPMorgan Chase & Co.-led bank syndicate and certain existing lenders to fund operations while it restructures. The money will be critical to provide comfort to Toys "R" Us vendors that they will be paid on time. Yesterday the stocks of some key suppliers such as Hasbro and Mattel were hit in advance of the filing.
When reports surfaced recently that Toys “R” Us was weighing a bankruptcy filing, Chinese toy scooter maker Pinghu Mijia Child Product Co. put all of the retailer’s orders on hold, fearing it wouldn’t get paid, according to sales manager Justin Yu, Bloomberg reported. The toy retailer represents about 10 to 20 percent of the Chinese supplier’s sales. “We were shocked to hear the news last week because their orders to us have been rising every year, so we did not know they were in trouble,” Yu said. “They’re a major buyer and I would say that the majority of toy makers in China would have some contracts with them.”
The bankruptcy filing by the company also may have global implications, especially for Chinese toy manufacturers. Some 38 percent of the company’s revenue came from overseas markets in the latest fiscal year. “It’s a loss for the long-term benefit of the entire industry,” said Lun Leung, chairman of Hong Kong-based Lung Cheong Group, a toy supplier for Hasbro Inc. He said Toys “R” Us accounted for less than 5 percent of the group’s sales.
“We expect that the financial constraints that have held us back will be addressed in a lasting and effective way,” Chief Executive Dave Brandon said. “Together with our investors, our objective is to work with our debtholders and other creditors to restructure the $5 billion of long-term debt on our balance sheet.”
The company's Canadian unit intends to seek protection in parallel proceedings under the Companies’ Creditors Arrangement Act (CCAA) in the Ontario Superior Court of Justice, Toys ‘R’ Us said in a statement. Operations outside of the United States and Canada, including about 255 licensed stores and joint venture partnerships in Asia, which are separate entities, are not part of the bankruptcy proceedings, Toys ‘R’ Us said.
As an indication of the challenges faced by the struggling retailer, the company opened a temporary store in New York City’s Times Square this year to capture more holiday shoppers, almost two years after it closed its flagship store barely a block away, driven out by high rents.
More than a dozen significant retail chains have filed for bankruptcy this year. Among them were Perfumania Inc, apparel chains rue21 Inc and Gymboree Corp, discount shoe chain Payless Holdings LLC and designer clothing chain BCBG Max Azria Global Holdings LLC.
The shakeout is also reverberating across American malls and shopping districts. More than 10 percent of U.S. retail space, or nearly 1 billion square feet, may need to be closed, converted to other uses or renegotiated for lower rent in coming years, according to data provided to Bloomberg by CoStar Group.
Major retailers including Macy’s and Sears Holding have closed hundreds of locations as they struggle to compete discounters such as Wal-Mart and Amazon.com. Amazon’s recent acquisition of high-end grocer Whole Foods Markets Inc stirred speculation that the online giant will use its pricing power and huge reach among U.S. consumers to go after market share of traditional brick-and-mortar grocers.
The company's full bankrtupcy filing is below:

Over the weekend, we reported that vendors to iconic toy retailer Toys "R" Us had halted shipments over payment concerns and/or getting their receivables crammed down alongside other unsecured claims ahead of what appeared to be an imminent bankruptcy. Well, they were right, and according to Bloomberg a Chapter 11 filing by Toys "R" Us is to be expected as soon as tonight.
The latest Amazon casualty, Toys "R" Us bankruptcy filing would send America’s largest toy chain to bankruptcy court, dealing another blow to a brick-and-mortar industry that’s already reeling from store closures and sluggish mall traffic and conclude the saga of one of the last pre-crisis LBOs in which Bain Capital, KKR and Vornado Realty Trust saddled up the company with $7.5 bilion in debt.
According to Bloomberg, the retailer has already hired a claims agent meant to help administer a Chapter 11 process. What is unclear is whether the company will have sufficient liquidity to assure its vendors who have imposed an effective COD blockade on the company, to provide it with much needed holiday season merchandise. And speaking of Toys "R" Us vendors, as speculation of a bankruptcy mounted over the weekend, their shares tumbled: Mattel, the maker of Barbie and Fisher-Price, fell 6.2% while Hasbro, which makes Monopoly, Nerf and Transformers, dropped 1.7%, its biggest decrease in almost two weeks.
Predictably, as we showed on Saturday, Toys CDS has exploded as the cost of insuring the company against default surged, with prices of six-month and one-year CDS hitting record highs.
Finally, the most amusing chart is that of Toys "R" Us bonds which crashed some more on the Bloomberg report, and which were happily trading at par until just a few weeks ago, only to be shocked by the recent news report that the company had hired bankruptcy advisors, crushing all hopes that the company's maturing debt would be rolled over, as even its PE sponsors decided they had had enough.
Once the filing hits the docket officially, we look forward to updating the full list of 2017 YTD retail bankruptcies which one can probably also call "Exhibit A" in any Amazon anti-trust hearing.

Last week's news that Toys “R” Us has hired bankruptcy lawyers Kirkland & Ellis to help restructure its heavy debt load, came as a shock to the company's creditors, who promptly sent its bond crashing from nearly par at the start of the month to 43 cents on the dollar as of Friday.
As Bloomberg first reported, K&E is focused on the $400MM in bond due 2081, while Toys “R” Us has also retained Lazard to help with debt refinancing. They will have their hands full: in addition to shrinking sales and heightened competition, Toys ‘R’ Us has been burdened with debt from an LBO12 years ago as a result of which Toys “R” Us’s private equity owners, Bain Capital, KKR and Vornado Realty Trust, loaded up the company with $7.5 billion in debt.
Last year, the retailer extended maturities on some of borrowings, giving it more time to execute a turnaround plan by Chief Executive Officer Dave Brandon. As part of his comeback bid, he was looking to spruce up stores with more toy demonstrations and other experiences - seeking an edge on online sites such as Amazon. However, last week's realization that the company is considering a debt-for-equity exchange, confirmed many worst fears that not only was the turnaround faltering but that underlying business was far weaker than expected.
The imminent restructuring, which judging by the shocking bond crash was completely unexpected, would help Toys “R” Us get its house in order ahead of the all-important holiday season, when the company has its biggest sales surge. Alas, now that the iconic toy retailer appears likely to cramdown at least one if not more creditor classes in some form of pre-pack Chapter 11, said sales surge may not happen at all if the company's suppliers suddenly get cold feet and refuse to stock up the company with much needed inventory.
Which is precisely what is happening.
Making matters worse, according to the WSJ, Toys ‘R’ Us could file for bankruptcy as soon as next week, while Bloomberg adds that nervous suppliers have scaled back shipments and tightened terms to the retailer ahead of the crucial holiday selling season, on worries they may not got repaid and their payables would be lumped alongside other unsecured pre-petition claims.
The vendors are balking as Toys “R” Us continues talks with lenders over a new loan that would allow the company to stay open while it works out a recovery plan through bankruptcy proceedings, said the people, who asked not to be identified because discussions are private. The loan is being marketed by Lazard Ltd. to banks and existing creditors, said one of the people.
Just like in the case of Sears discussed here at the end of August, suppliers have pulled back in part because the cost to insure their shipments to cash-strapped Toys “R” Us has become too expensive, according to Bloomberg sources. Since vendors traditionally rank among other unsecured creditors under a bankruptcy waterfall schedule, their decision on whether to continue shipping goods can play a large role in determining a retailer’s fate.
Unfortunately for Toys “R” Us, now that it has entered the self-reinforcing death spiral of collapsing liquidity and panicked vendors, it needs to find a financial solution immediately and resume shipments because the cash-strapped chain makes about 40% of its sales during the fourth-quarter holiday season. Much of its strategy revolves around getting exclusive products from key vendors, along with support for advertising and marketing.
For now, the toy merchant has been seeking to refinance $400 million of debt that comes due next year, although media reports suggest that the process has stalled. As a result, the company is now openly flirting with bankruptcy as an option although no decision about seeking court protection has been made.
Still, as Bloomberg calculates, Toys “R” Us has remained oddly profitable, generating $790 million in EBITDA, the most since 2012, yet even that is not enough to appease vendors many of whom now demand payment upfront. Not everyone thought: Hasbro is among toymakers that hasn’t curtailed shipments, spokeswoman Julie Duffy wrote in an email. “We continue to partner and ship, conducting business as usual, while managing our risk across all retailers to the appropriate levels,” Duffy wrote.
Hasbro may regret this decision very soon as according to the the company's 5 Year CDS, which in recent days have soared to 46 points upfront...
... the probability of default in the next five years is now 93%, and 60% over the next 12 months.
A Toys ‘R’ Us restructuring would add to a list of 25 retailers, including Rue21, Gymboree and Payless Shoe Source, that have filed for bankruptcy since the beginning of 2017. Another big box chain, Staples Inc., recently agreed to be taken private in a leveraged buyout.
Source: @ReorgFirstDay
While industrywide, toy sales have been strong in recent years, much of the growth is shifting to online sellers like Amazon.com Inc. and discounters like Wal-Mart Stores Inc. Amazon’s toy sales were up 24% last year, compared with 5% for the overall market and five years of declines for Toys “R” Us, according to analytics firm One Click Retail.
The company is not alone as it finds it is woefully behind in its competition with Amazon: some large toy brands, such as Lego and Star Wars, have also struggled recently, while the collectible Shopkins toys, which Toys ‘R’ Us helped launch, is on the downswing. Earlier this month, Lego AS reported its first decline in sales in 13 years and said it would cut 8% of its workforce. Another toy maker, Mattel Inc., replaced its chief executive earlier this year after a slide in holiday sales.
Ultimately, whatever the fate of Toys 'R' Us may be, it will inevitably go through bankruptcy court: according to the WSJ, in recent weeks Toys ‘R’ Us’s advisers have been hunting for a DIP loan to fund operations under chapter 11, effectively guaranteeing that a bankruptcy filing is now just a matter of days.

When it comes to building a more innovative culture, lots of companies wring their hands. A few actually take bold steps to make it happen. One such organization is Hong Kong-based Li & Fung, which manages the supply chains for hundreds of retailers and brands around the world.

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“THE PRD WAS always the first mover in China,” explains William Fung of Li & Fung. Hong Kong’s success, he reckons, owes much to its tendency to ignore Beijing’s diktats. And Shenzhen’s special economic zone did well because it operated as a freewheeling hub. By embracing globalisation and eschewing central planning, the cities of the PRD led the way for the country’s economic opening.
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Markets trembled this week as the People’s Bank of China engineered a 2% devaluation of the yuan against the dollar. Expected winners are big Chinese exporters like Li & Fung, Huawei and Lenovo which presumably means losers include exporters from other nations. The fear is that a “currency war” could [...]